Are Homeowner Mortgage Deductions a Good Idea?

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Many Americans benefit from a generous tax deduction for home mortgage interest. Here's why many economists, both liberal or conservative, think this particular entitlement is a bad idea (and why it's unlikely to go away).

Early History of the Home Mortgage Interest Deduction

The home mortgage deduction came along with with the federal income tax, which was first inaugurated in 1896, found unconstitutional, then reinstated by Congress in 2013 along with the constitutional amendment that validated it.

Authorities, among them Dennis J. Ventry, writing in the journal "Law and Contemporary Problems," generally agree that Congress hadn't intended to hand the middle-class this particular subsidy. Instead, the mortgage interest deduction was included with a general interest deduction intended to help businesses subject for the first time to a tax on income.

Congressional failure to exclude home mortgage interest from the general deduction of interest didn't seem that important in 2013. It was largely only the affluent who lived in their own homes; home loans weren't widely available for the middle-class until the postwar period of the mid-1940s. Also, when the income tax and the accompanying deduction for interest began in 1913, the first $3,000 of interest paid was not deductible. Since something like 99 percent of Americans at that time earned less than $3,000 a year, deducting interest payments above $3,000 was, for almost everyone, of theoretical interest. And, of course, the very wealthy remaining 1 percent didn't take out home loans anyway; they paid cash.

The Law of Unintended Consequences

As home loans became more common in the postwar period, the deduction of mortgage interest became more significant. Critics began noting that it was a gift handed to a middle-class that could afford a mortgage that came at the expense of a higher tax rate generally. The federal income not earned on mortgage interest had to be made up elsewhere. The unintended effect was to disadvantage poorer Americans – effectively, the home mortgage interest deduction became a tax penalty handed to the poorest Americans for not being able to afford a mortgage.

On the other hand, realtors, builders and savings and loan institutions loved the mortgage interest deduction because it made home ownership more affordable. From 1984 onward, when there was a serious (and for the home loan lobby alarming) move to end this particular tax subsidy, lobbyists put increasing pressure on Congress to support the subsidy. Popular print and television ads extolled the moral and familial benefits of home ownership. Not supporting the deduction was framed as un-American – a failure to fulfill the promise of our democracy.

There's nothing harder to legislate against than an entitlement. It's often said, for instance, that arguing against another huge entitlement program, Social Security, is to touch the third-rail of U.S. politics – whoever tries it gets voted out of office.

Something like that explains the continuing history of economists appearing before Congress to argue the unfairness of the home mortgage interest deduction, followed by legislative activity to amend the current tax law, along with passionate anti-reform lobbying and advertising to preserve it. Legislators, who may be fearful of the housing lobby, then begin to amend the reform proposal to make it less objectionable. Eventually, the amendments proposing the watering down of the anti-deduction initiative make it relatively painless for even proponents of reform to give up because there's not much left at stake.

Recent Arguments Pro and Con

Home prices in the U.S have soared in the period following the financial meltdown of 2008 (a meltdown substantially caused by a similar housing boom from 2000 to 2007). Homes have become unaffordable for larger segments of the U.S population, especially in large cities and along all three coasts. This has prompted new calls for reform or even elimination of the home mortgage deduction.

Some of the recent objections to the continuation of the home mortgage deduction its current form are that:

  • It encourages Americans to take on higher levels of debt than they can really afford, thus destabilizing the banking industry.
  • It further disrupts an already bloated housing market by subsidizing living costs for a selected segment of the population – which can then pay increasingly lofty housing prices.
  • It benefits most those Americans who don't need federal housing assistance at the expense of those who do.   

Enthusiasts of a continuation of the subsidy have fewer arguments to support it, most of them centering around:

  • The positive effect of homeownership on American families.
  • The harm to American business that could result if it were reduced or eliminated.

What's Next?

In mid-2017, various parties have tried to bridge the gap between those who think the mortgage deduction's a terrible idea and those who insist that ending it will imperil the economy. One popular group of suggestions has introduced various ways of limiting the interest amount that's deductible. Mortgage interest, for instance, could be deducted only on mortgage amounts of $500,000 or less (the upper limit is now $1 million). Alternatively, it could be progressively scaled back beginning at some lower mortgage amount – $250,000, for instance. President Donald Trump has proposed a resetting and general lowering of tax rates that would have the effect of making the deduction proportionately less important.

Anything's possible and reform may finally be on the way. But upper-middle class Americans go to the voting both more often than the poor and only the wealthy – who benefit most from the deduction – can afford substantial campaign contributions to politicians who will oppose reform. Some skepticism seems justified.


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